Signs Of The Times

"Up until April, the market for risky loans was so lenient borrowers
could cut their interest rates simply by asking - rather than providing
anything to - investors.

After a remarkably permissive first quarter, investors put their collective
foot down in April to slow the pace of refinancing to a near halt."

Wall Street Journal, April 27

"Binge Stirs Credit Fear

John Lonski, Chief Economist at Moody's, said a surge in high-yield
bank credit facilities - term loans and lines of credit with junk ratings
- resembles the jump in subprime borrowing at the end of the housing cycle."

Financial Post, May 16

"Borrowing Binge Fuels U.K. Economic Worries

Consumer debt soars as mortgage rates rise: banks draw the line."

Wall Street Journal, May 10

DEARTH OF CREDIT

The full understanding of credit and its cycles has been provided by the Austrian
School of Economics. Its leading exponent has been Ludwig von Mises and some
of his comments bear witness to today's one-way excesses. It is imperative
to have an understanding of credit that works in both financial and tangible
asset booms.

"An increase in the quantity of money or fiduciary media is an indispensable
condition of the emergence of a boom. The recurrence of boom periods, followed
by periods of depression, is the unavoidable outcome of repeated attempts
to lower the gross market rate of interest by means of credit expansion.
There is no means of avoiding the final collapse of a boom brought about
by credit expansion. The alternative is only whether the crisis should come
sooner as a result of voluntary abandonment of further credit expansion,
or later as a final and total catastrophe of the currency system involved.

The breakdown appears as soon as the banks become frightened by the accelerated
pace of the boom and begin to abstain from further credit expansion. The
change in the banks' conduct does not create the crisis. It merely makes
visible the havoc spread by the faults which business has committed in the
boom period.

The dearth of credit which marks the crisis is caused not by contraction
but by the abstention from further credit expansion. It hurts all enterprises
- not only those which are doomed at any rate, but no less those whose business
is sound and could flourish if appropriate credit were available. As the
outstanding debts are not paid back, the banks lack the means to grant credits
even to the most solid firms. The crisis becomes general and forces all branches
of business and all firms to restrict their activities. But there is no means
of avoiding these consequences of the preceding boom.

Prices of the factors of production - both material and human - have reached
an excessive height in the boom period. They must come down before business
can become profitable again. The recovery and return to "normalcy" can only
begin when prices and wage rates are so low that a sufficient number of people
assume that they will not drop still more."

The Austrians did not distinguish between financial and tangible asset booms,
and did not provide any examples or a forecasting model.

The latest FOMC stuff indicated the Fed was professionally worried about “inflationary'
pressures, which was keeping administered rates up.

The irony is that typically the senior central bank's changes in administered
rates are a number of months behind the change in short-dated market rates
of interest.

Since the high of 5.18% on February 23 the 3-month treasury bill has plunged
to 4.74%. This is beginning to look like rather a fast move that senior central
banks will dutifully follow.

As we noted in December 2000, interest rates going up indicates that the boom
is on and that falling rates indicate the boom is over.

What's more, the bigger the boom the more dramatic the decline in short-dated
interest rates.

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